Tether Not a Ponzi But Susceptible to Shutdown

In the last couple of months, everyone from Ari Paul to Weiss Ratings has weighed in on the Tether debate, seeking to address the legitimacy of the company and its likelihood of coming unstuck at the hands of U.S. regulators. Now Bitmex Research has chipped in, and while its report won’t be the last word on the matter, it may quell some of the more pointed criticisms labeled against the company and its opaque practices.

Blessed with the time, budget, and platform to dive deep into cryptocurrency projects, Bitmex Research is able to go where other investigative reporters can’t or won’t. Its forensic examination of Ripple, a fortnight ago, earned widespread praise, and its Tether report is another big hitter. The opening abstract dismisses some of the more persistent concerns surrounding the company and its USDT stablecoin, but supports others, noting:

There is some scepticism about Tether, with accusations that the system is not backed by sufficient reserves. We think that scepticism is misplaced. We have found possible evidence in published financial data that the impact of Tether may be visible in Puerto Rico’s banking system. Tether is likely to be, or is already, encountering problems related to regulation and we think this should be the primary long-term concern for Tether holders.

This tallies with a growing consensus which holds that Tether probably does have the assets to back its dollar-based tokens, but is still susceptible to regulatory pressure, specifically that emanating from the U.S. Most critics aren’t as vehement as Tether maximalist Bitfinexed, the pseudonymous Twitter account synonymous with scrutinizing the company’s operations.

Bitmex: Tether Doesn’t Need a Blockchain

Investigating the November hack that saw $31 million of USDT stolen and subsequently isolated by Tether, Bitmex writes: “The hacking incident demonstrated that Tether is effectively in complete control of the ledger, as they can force a hard fork at will and reverse any transaction…This raises the question of why Tether bothers to put the database on the Bitcoin and Ethereum blockchains at all — it would be far cheaper for Tether to create its own public database without needing to pay fees to the miners.”

Bitmex Research then goes on to acknowledge Tether’s famous lack of transparency, but notes “Lack of transparency does not indicate fraud”. This tallies with a recent report by security researcher Nicholas Weaver. Bitmex also concurs with Weaver that Tether is likely to encounter issues in regards to money laundering and accusations of enabling criminality through the degree of anonymity that the service provides:

[Tether’s] characteristics potentially make it attractive to criminals, just like Bitcoin…Regulators are unlikely to be particularly happy about this and banks are likely to consider Tether with scepticism. Tether also requires the use of a bank, to hold the USD reserves required to back Tether. Many banks are therefore likely to be very cautious in respect of this issue and if Tether is accepted as a client, it may violate the banks’ compliance procedures such as rules meant to prevent money laundering.

Puerto Rico: a banker’s paradise?

A Paucity of Audits but a Plenitude of Money

Calculating Bitfinex to have been making $10 million in exchange fees a day at the height of bitcoin mania, Bitmex opines that Tether likely has plenty of assets, either directly, or indirectly via Bitfinex, should the need arise. The report then extensively deals with rumors that Tether is seeking to set up banking operations in Puerto Rico, where regulators take a more hands-off approach. It’s possible, opine the report’s authors, that all of the fiat currency backing tethers is stored in the Puerto Rican banking system. While far from perfect, this arrangement – if true – shoots down the allegation that Tether is a Ponzi scheme with nothing backing it.

The report finishes by looking over the many unlicensed money transmitters the U.S. has shut down in the past including Liberty Reserve and E-Gold, before making some robust recommendations:

In our view, Tether therefore has two choices: 1. Reform such that the system includes KYC/AML procedures enabling the operator to easily block transactions or freeze funds…2. Continue as it is and risk being be shut down by the authorities at some point.

It concludes: “If Tether is shut down, history shows us that there is a risk some users may lose access to their funds, perhaps temporarily. Therefore we do not recommend holding Tether for the long term”.